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Business or Hobby? Taxes on Revenue or Profit?

Hello, I'm in my first year of running a small sole proprietorship as a
photographer, in addition to my regular full-time employment with a private
corporation.
I need more help understanding whether my sole proprietorship constitutes a
business or a hobby, and if a business, whether I should pay taxes on my
revenue or my profit. First, the "Business or Hobby?" question.
There doesn't seem to be a litmus test with a bright-line standard, but
here's how I would answer each of the questions in the IRS publication:
Does the time and effort put into the activity indicate an intention to make
a profit? Yes.
Does the taxpayer depend on income from the activity? No.
If there are losses, are they due to circumstances beyond the taxpayer's
control or did they occur in the start-up phase of the business? Occurred in
the start-up phase of the business (this is the first year)
Has the taxpayer changed methods of operation to improve profitability? No.
Does the taxpayer or his/her advisors have the knowledge needed to carry on
the activity as a successful business? Yes.
Has the taxpayer made a profit in similar activities in the past? No.
Does the activity make a profit in some years? N/A - first year
Can the taxpayer expect to make a profit in the future from the appreciation
of assets used in the activity? Yes.
So, based on my answers, am I properly categorized as a business or a hobby?
My total devotion to this "employment" comes to about 4-6 hours per week.
Now, the numbers: My revenue calendar YTD has been $1166.19. My expenses have
been $1551.28, for a loss YTD of $385.09.
Do I owe income tax on my revenue? Can I claim the operating loss as a
business loss? I don't think I owe self-employment taxes since my profit was
less than $400 for the year, right? Last question: If I do owe tax on my
revenue, where does it go in my tax form since I am just a sole proprietor
(not incorporated, etc.)?
Thanks for your time and advice!
Sincerely,
kjbgu04

BizResearcher | Window Shopper |
11/28/2012 - 11:13 am

As a sole proprietor, you pay taxes by filing a Schedule C with your personal
income taxes. You pay taxes on the net profit, not on gross revenue. If you
intend to keep the business active, you have registered the name, obtained a
sales tax permit and an EIN and opened a business bank account, then you are
a business. You can therefore deduct expenses in excess of income and declare
a loss. However, you cannot do that year after year without raising a red
flag with the IRS. As KMurray, suggests, you may want to visit with a
counselor at a small business development center or a SCORE office in your
area. Their services are free and they can provide guidance.

kmurray | Community Moderator |
11/27/2012 - 4:06 pm

Hi, Reaching out to one of SBA's resources partners could be a great step in helping you answer these specific questions. SCORE, Women’s Business Centers and Small Business Development Centers are located across the country and provide free business counseling to individuals looking to start or expand a small business. Visit our local assistance guide to find your local SBA resource partners by entering your zip code. Good luck!